Professional Documents
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International Financial MGMT
International Financial MGMT
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Hedging defined:
A firm or an individual hedges by taking a
position, such as acquiring a cash flow, an
asset or a contract, that will rise (or
fall) in value to offset a fall (or rise) in
the value of an existing position.
A perfect hedge is one eliminating the
possibility of future gain or loss due to
unexpected changes in the value of the
existing position.
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Transactions exposure
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Transactions exposure
The payoff from an unhedged long position, say
accounts receivable in 90 days in euros.
[F90 - S90]
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Transaction exposure
An unanticipated
gain
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Transaction exposure
An unanticipated
loss
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Transactions exposure
An unanticipated
loss
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Transaction exposure
An unanticipated
gain
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Transaction exposure
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Transaction exposure
Here is the payoff diagram assuming a 10% revaluation of
the yuan.
Transaction exposure
An unexpected devaluation of the yuan, for example due to
capital account liberalization, may increase the yuan value of
your accounts receivable by 1.000 yuan per dollar. Since you
receive $100,000 in 90 days, their new value in yuan are
9.28*100,000 =928,000 yuan. In other words, you might
unexpectedly gain as depicted in the payoff diagram.
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Operations exposure
Operating exposure measures the changes in
the net present value of a firm due to
unexpected changes in exchange rates.
It is a forward looking concept which reestimates the discounted cash flow in foreign
currency in terms of home currency for
overseas operations following an unexpected
change in the exchange rate.
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Operations exposure
Parker Pens European operations involve
both the production and sale of pens in
the European Community. It has a
partial natural hedge in that its direct
costs of production are in euros. When
the dollar price of the euro rises, both
expected revenues and costs in euros rise
by the same percent.
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Operations exposure
However, if the cash flow in euros is
positive, the euro appreciation adds to
earnings in dollars. When the dollar
price of the euro falls, expected net
earnings in euros suffer a fall in value in
terms of dollars.
This is known as operating exposure.
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$
$
3,000,000
1.2878
3,863,490
$
$
$
1.0000
3,000,000
(863,490)
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$
$
$
3,863,490
1.0000
3,863,490
-
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$
$
3,000,000
1.2878
3,863,490
$
$
$
1.5000
4,500,000
636,510
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Conclusion
A firms free cash flow from overseas
operations is subject to exchange rate
risk.
By changing economic variables,
purchasing contracts, or seeking
offsetting matching currency flows, a
firm can hedge against exchange rate
losses.
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